How to calculate a commercial rent increase?

• A commercial rent increase is calculated at the discretion of both parties to the lease agreement. They negotiate to set fair and equitable increase. As a landlord, you can use different criteria to propose a reasonable commercial rent increase such as:

• The renovations that have been done.

• The vibrancy of the neighborhood where the rent is located.

• The reputation of the building.

• The increase in municipal or school taxes.

• Variation in the insurance premium.

It is also recommended to compare, if possible, the number of commercial rents in the area. When doing so, make sure the rents have the same characteristics as yours. This way, you will have the correct information. Once you have read this article, you can determine an appropriate commercial rent increase.

The lease of a commercial property

You should know that commercial rents are governed by the rules of the Civil Code of Québec. According to Section 1851 C.c.Q., ‘‘Lease is a contract by which a person, the lessor, undertakes to provide another person, the lessee, in return for a rent, with the enjoyment of movable or immovable property for a certain time. The term of a lease is fixed or indeterminate.’’

The commercial lease is therefore a contract as defined in sections 1378 and 1385 C.c.Q. As a result, a commercial lease is formed by the simple exchange of consent by the parties, with no need for any other formality. It is therefore the negotiating strength of each party that will guide its terms, including the value of the rent.

The difference between a residential and commercial rent

First of all, a commercial lease does not have any public policy provisions, unlike a residential lease. This means that there are no provisions in the law to protect the tenant of a commercial lease, unlike the tenant of a residential lease. In fact, the lease of a dwelling grants certain privileges to the tenant such as :

• Protection against abusive rent increases
• The right to maintain the premises
• A specific legislative tool (Tribunal administratif du logement).

These measures are intended to strike a balance between the parties and to avoid disproportionate evictions. The law considers that the tenant of a dwelling is generally weaker from an economic point of view than the landlord. However, this does not apply in the case of a commercial lease. The tenant does not have the right to remain on the premises and there are no provisions to protect him or her against abusive rent increases. The drafting of a commercial lease is the result of negotiations between the landlord and the merchant who wants to run a business.

When you rent, it is important to clearly define the nature of the lease to avoid confusion. Be aware that a residential lease does not apply when more than one-third of the total area is used for a purpose other than residential as mentioned in section 1892 C.c.Q.

For instance, if a painter wishes to set up his studio in his dwelling and sell his paintings there, he must calculate the surface area to sign the right type of lease. It is also very important for all commercial tenants to publish their lease as soon as possible at the Bureau de la publicité foncière (Registre foncier), to protect their rights in the event of the sale of the building.

The obligations of the parties to a commercial lease

The rules relating to commercial leases are, for the most part, those that apply to leases in general. The section of the Civil Code of Québec entitled “Rights and Obligations Resulting from a Lease” extends from article 1854 to 1876. It details, of course, the rights and obligations of the parties, some of which are listed below:

• The lessor is bound to deliver the leased property to the lessee in a good state of repair in all respects and to provide him with peaceable enjoyment of the property throughout the term of the lease. (Section 1854 C.c.Q.).
• He is also bound to warrant the lessee that the property may be used for the purpose for which it was leased and to maintain the property for that purpose throughout the term of the lease.(Section 1854 C.c.Q.).
• The lessee is bound to pay the agreed rent and to use the property with prudence and diligence during the term of the lease. (Section 1855 C.c.Q.).
• The lessor is bound to warrant the lessee against legal disturbances to enjoyment of the leased property. (Section 1858 C.c.Q.).
• Before pursuing his remedies, the lessee shall notify the lessor of the disturbance.
• A lessee is bound to act in such a way as not to disturb the normal enjoyment of the other lessees.
• He is bound, towards the lessor and the other lessees, to make reparation for injury that results from a violation of that obligation, whether the violation is due to his own act or omission or to the act or omission of persons he allows to use or to have access to the property.
• In case of violation of this obligation, the lessor may apply for resiliation of the lease. (Section 1860 C.c.Q.).

In the event of non-compliance with these obligations, you will have to resort to the common law courts such as the Court of Québec or the Superior Court. Please note that the Tribunal administratif du Logement does not have jurisdiction to hear disputes regarding a commercial lease.

It is also important to know that articles 1851 to 1891 C.C.Q., which relate the rights and obligations of the tenant and the landlord, are not of public order in the context of a commercial lease. This means that the lessee and the lessor can agree on different rules than those set out in the Civil Code of Québec.

The provisions of the C.C.Q. will only apply if the commercial lease is silent on the rights and obligations of both parties to the contract.

The structure of a commercial rent

Although it is not mandatory that a commercial lease be in writing, it is strongly recommended that it be written for obvious reasons. Generally speaking, most commercial rents are written in a detailed and precise manner. According to Section 1895 C.C.Q., the commercial lease must include certain information such as:

• The name and address of the lessor.
• The name of the tenant.
• The amount of the rent.
• The address of the dwelling.

Usually, it also contains:

• The type of space being rented.
• The terms of payment of taxes.
• Clauses regarding the use and maintenance of the premises.
• Information regarding the transfer of the lease.
• The obligations and responsibilities of the parties.
• The terms of the lease.

In a commercial rent, it is possible to draft clauses that would be considered invalid in a residential one. For example, it is common to find the following statement in a commercial rent: “The tenant shall pay, in addition to the fixed monthly rent (base rent), all or part of the expenses of the leased building, such as insurance or property and school taxes of the building.” Such a clause would be illegal in a residential lease.

The duration of a commercial rent

According to Section 1851 C.c.Q., the term of a commercial lease can be fixed or indeterminate. The parties choose the type of lease during the negotiations. Depending on their decision, different rules will have to be followed with respect to the termination of the lease. Moreover, article 1877 C.C.Q. clearly explains the provision on this subject: “A lease for a fixed term ceases by operation of law upon the expiry of the term. A lease with an indeterminate term ceases when it is terminated by either of the parties.” It is therefore very important to understand the difference between these two commercial leases. You should also know that the law does not require a minimum term for a commercial lease. The landlord and the tenant are free to select a term that suits them.

The only rule to be respected concerning the duration is set out in Section 1880 C.c.Q. et se détaille comme suit : “The term of a lease may not exceed 100 years. If it exceeds 100 years, it is reduced to that term.” The parties therefore jointly determine the term of the commercial lease and write it in the contract.

Types of rents related to commercial operations

When signing a commercial rent, it is not uncommon for the obligations of the lessees and lessors to be very detailed. Classification of commercial leases has therefore appeared over the years to counter this lack of information.

It is therefore essential to know the different types of leases and to understand them well to avoid unpleasant surprises. Keep in mind the following elements when negotiating with your tenant:

• The expenses related to your building.
• The repairs to come or to be done immediately.
• The type of repairs to be included in the lease.
• Insurance, maintenance, and taxes.

This way, you can be sure to choose the best commercial lease for your real estate situation.

Gross lease

This is the least complex lease. In this case, a fixed monthly rent is determined and covers all expenses related to the building. The tenant does not have to pay any additional costs such as electricity, maintenance fees, or the cost of renovations. In most cases, the gross rent per square foot will be higher than in other types of leases.

Gross lease with an escalation clause

This lease has a unique feature relating to rent increases. The escalation clause provides that the cost of rent will be subject to changes in property taxes. If there is a 3% increase during the year, the rent will also be increased by 3% on the day of renewal.

Also known as an Indexation Clause, it is possible to include it in the commercial lease contract in two ways. It can provide that the increase or decrease in property taxes will have an impact on the rent increase. This can be determined during the negotiations.

Net lease

The net lease places the burden of maintenance costs on the tenant. However, the landlord is responsible for operating costs and taxes. The landlord will also be responsible for the cost of major renovations such as structural, foundation, or roof repairs.

Net-net lease

Many costs are added to the tenant in the case of a net-net lease. Here, the tenant must pay the amount of the initial rent as well as:

• Operating expenses.
• The cost of major repairs.
• A portion of the tenant’s revenue.

The landlord, however, is responsible for all costs related to insurance, maintenance, and taxes.

Net-net-net lease

Also known as a triple net lease, this contract states that all costs related to the commercial operation of the rent are assumed by the tenant. The tenant must therefore pay the following amounts

• The basic monthly rent.
• Property taxes.
• Operating expenses.
• Maintenance costs.
• Costs of major or minor renovations.

Net-net-net-net lease

This is the least conventional commercial lease. This type of contract can be made in the case where the owner sells his building but remains a tenant of it.

The tenant (who is in reality the former owner) assumes all charges and repairs of the building.

All of these expenses are paid in proportion to the surface area of the rented premises.

The triple net lease allows the landlord to detach himself from any obligations or responsibilities related to the rent.

How to effectively calculate the increase of a commercial lease?

Since this increase is not governed by law, you can base it on different criteria, as mentioned above. Here are the main elements to take into consideration:

• Renovations carried out.
• The effervescence of the neighborhood where the rent is located.
• The reputation of the building.
• The increase in municipal or school taxes.
• Changes in insurance premiums.

You can also ask a real estate professional such as a leasing agency or a commercial real estate broker to help you with this. The broker or agency can even do the renting for you and save you time. Rent increases do not have to be annual. In general, it is spread over a period of time varying from 3 to 5 years according to the total duration of the lease.

Analyze the commercial rent area

To establish a reasonable rent increase, monitor the real estate market in your area. At the same time, make comparisons and analyze the elements in demand that may have an impact on the rent increase, such as

• Accessibility to a loading dock.
• Availability to washrooms and some independent entrances.

Once you have this information, you will be in a better position to set a suitable rent increase.

Validating changes to commercial rent

To calculate a fair commercial rent increase, consider any major renovations or repairs to the space or building.

Has there been an increase in the size of the rent? Has the roof been changed? Have there been cracks in the foundation that required professional attention?

If so, these items may justify the lease increase you are proposing to your tenant.

Check the increase rate of commercial rents in Quebec

A helpful tool is the Statistics Canada website. You will find the rates of increase in commercial rents for all provinces in Canada.

It is possible to see that Ontario is the province that has experienced the highest increase in the commercial rental market (+2.1%), mainly due to the lease increases for retail buildings (+2.9%) and industrial and warehouse buildings (+2.3%).

As for Quebec, Montreal showed one of the highest increases, +2.8% for commercial office leases. However, commercial rents remained generally stable in the province of Quebec.

What is a reasonable commercial rent increase ?

Overall, all you need to do is do some calculation with the variables named throughout this article. Also check out Commercial Rents Services Price Index to help you calculate your commercial rent increase. Keep in mind that a reasonable rent increase will pay for itself and therefore allow you to foster a good relationship with your tenant. Also, don’t forget to pay special attention to the economic climate. You don’t want to scare your tenant away!

You are now ready to calculate a commercial rent increase in an efficient and fair manner. Negotiations will no doubt be necessary to set an increase that will please both parties to the contract. During these discussions, remember to listen to your tenants in order to maintain a good business relationship. Be diligent and act in good faith!